Charitable Remainder Trusts: Reduce Taxes While Supporting Causes You Care About

One thing that often comes up when tax planning for clients is charity. Most business owners know they can receive tax benefits for giving to a cause that’s close to them, but they’re not quite sure what the best way to do it is from a tax perspective.

Luckily, it’s possible to strategically coordinate your charitable goals with your business sale to minimize the amounts of taxes you pay while leaving money to a good cause.

What is a Charitable Remainder Trust?

A Charitable Remainder Trust (CRT) is a tool that does exactly that. A CRT is a trust that has two main beneficiaries – an income beneficiary (you as the seller/person who made the gift) and a remainder beneficiary (the charity).

The income beneficiary is entitled to live off the trust during their lifetimes.

The remainder beneficiary then receives what is left, or the remainder, when the income beneficiary passes away.

In a CRT, you, the business owner (and your spouse), are the income beneficiary and the charity is the remainder beneficiary. You live off of the trust while living and then it passes to your named charity at death.

There are two major types of CRTs – CRUTs and CRATs. A CRUT is Charitable Remainder Unitrust. To oversimplify things, a CRUT means that you will receive a % of the trust each year. If the trust increases in value, you receive more, and if it decreases in value, you receive less. A CRAT is a Charitable Remainder Annuity Trust. In a CRAT, you receive a fixed payment regardless of how the trust grows.

How does a CRT save you money on taxes when selling your business?

So how does it work? As a charitable entity, the CRT does not pay taxes. This means that you can transfer your business shares to a CRT, receive a charitable deduction, and then the trust won’t owe taxes on a future sale.

That’s exactly how people structure these. The business owner transfers their shares to the trust, the trust eventually sells the business, and then the owner lives off an income payment each year.

As you can imagine, that sounds nice but there are a few rules/requirements to be aware of.

While most businesses are eligible, S-Corp stock cannot be transferred to a CRT as a CRT is not an eligible S-Corp shareholder. S-Corp assets can be transferred, but the term of the trust is then limited to 20 years.

Trust designers can get very creative, but generally, you take a fixed amount or a set percentage of the trust out each year for income. The minimum is generally 5% of the trust as your income payment each year. You can receive a higher percentage if desired, but that decreases the tax benefits as less will be there for charity when you pass.

Do I pay taxes on my income from a CRT?

A CRT defers taxes but does not fully eliminate them. As a result, there are taxes when you receive your income payments.

These taxes are calculated based on how the trust realized its income within the trust. If the trust earned interest, you pay taxes on interest, if the trust earned capital gains (which will happen in a business sale) you pay capital gains, and so on and so forth.

These taxes follow a 4-tier ordering rule, colloquially called Worst in First Out. This means income subject to ordinary income gets paid out first. With a CRT it’s not permanent tax elimination; but you do get an upfront tax deduction paired with deferral on the taxes until you begin to receive income.

How long can my CRT payments last?

Generally, the term of the trust can be set to a maximum of 20 years or the lifetime of the income beneficiaries. You can also have a joint income beneficiary which can extend the payment duration, most commonly this is a spouse. This can be set when the trust is created.

Another item to note is that these gifts are irrevocable. Due to the nature of the tax benefits, there’s no takebacks and no changing your mind. One benefit of this is that these trusts are creditor protected. If that is a major concern, discussing this with your attorney is highly recommended.

When do I need to set up my CRT before my business sale?

While you don’t need the full 3 years it takes for an ESOP or QSBS, you can’t transfer your business to a CRT the day before a sale. If you do, the IRS will “assign” your sale to you personally and you’ll still owe taxes. There’s no hard and fast rule on when the gift needs to be made, but the more time before a sale the better. Once an LOI is signed, it’s definitely off the table.

How does a CRT affect my heirs?

One concern that some business owners have is their heirs. If the business is almost all of your estate, you may be disinheriting your children by setting this trust up, as the balance at death goes to the charity.

A common tool to avoid this is combining your trust with a life insurance policy. Usually, the cost of a life insurance policy is much lower than the taxes saved so you can execute this strategy, set up a life insurance policy (sometimes within what’s called an ILIT), keep your heirs whole, AND leave a sizable gift to a charity that you care about. Sounds pretty good to me.

If you would like your heirs to have control of future donations or are concerned about your favorite charity changing its values, your remainder beneficiary could be set as a Donor Advised Fund or Private Foundation. These allow your children to direct the future gifts but come with additional considerations and complexity.

Case Study: How would a CRT benefit the Daniels?

Now that we know how a CRT works, let’s take a look at our favorite Daniels family to see how a CRT would benefit them. The Daniels own Daniels Engineering, which is currently valued at $10,000,000 and has $500,000 in basis. They are considering selling the business and donate to their local food bank regularly. They would like to see if a CRT would benefit them.

Note, for the charitable deduction value, we are using this calculator and have the beneficiaries set at age 65. IRS rates fluctuate and will determine the charitable deduction received at the time of the gift. The calculator had the IRS 7520 rate set at 5%.

There are a few things to note from this example. First, there is a significant charitable deduction in year 1. Since the sale of the business is happening with the CRT and is nontaxable, that deduction can offset other ordinary income. If there is no income, you can also carry the charitable deduction forward for 5 years.

When you add those savings to the net proceeds difference, you can see that the CRT generates a substantial amount of wealth.

You can also see that the 5% payment received is higher than the equivalent 5% that you would receive from your post-tax account. One thing to note is that you will pay taxes on the payments received as they come out of the trust, which will slowly erode some of the tax savings over time.

So, all in all, this plan looks great for the Daniels assuming that they have a charity that they care about. As we mentioned before, they could always pair this strategy with a life insurance policy for their children. If there’s also concern about the charity itself changing their values, they could go for a more flexible option like a DAF or Private Foundation that their heirs could control. This would allow their heirs more flexibility related to how the charitable proceeds are managed, although there are tradeoffs there as well.

What requirements does a CRT have?

• Remainder interest in the trust goes to a charity
• Limitations on payment terms (set % or amount each year)
• Taxes due on payments received
• Timing cannot be too close to sale and cannot have a signed LOI
• Direct S-Corp stock transfers not permitted (you can reorganize your business)
• Irrevocable

When can I do a CRT to save taxes on the sale of my business?

As mentioned, timing on a CRT is less clear than other options. However, it requires pre-planning, you do not want it too close to the sale, and you CANNOT do it once there is a signed LOI. If you can have the gift occur in another tax year, it would help your case.

What’s the Downside to a CRT?

• CRTs are irrevocable
• Your heirs may be disinherited
• There are administrative/legal fees to set up and administer your trust

Who is a CRT best for?

A CRT is best for business owners who don’t need the full sales proceeds immediately, would like to leave a benefit to charity, and would like to save taxes along the way. It may also benefit business owners who are concerned about asset protection.

How do I set up a CRT?

1. Review available strategies
2. Review financial model of CRT
3. Verify charitable intent and beneficiary
4. Engage estate planning/tax attorney
5. Determine CRUT vs CRAT structure
6. Select qualified trustee
7. Select qualified administrator
8. Transfer assets (timing critical)

How can Ironclad Help with Your CRT

At Ironclad Wealth Management, we specialize in helping our clients reduce taxes each and every year, and especially when considering a business sale. Once we complete our analysis and conclude that a CRT is right for you, we quarterback the process every step of the way.

We will help you locate the right attorney (if you don’t already have one), the right trustee, and the right plan administrator as part of our process. Once the trust is set up, we can assist you with insurance planning, if desired, and the investment management of the trust to help achieve your long-term goals and close your Wealth Gap.

Schedule a consultation with Ironclad Wealth Management to explore your personalized capital gains tax strategy and see if a CRT is right for you.

Want to Keep Reading more about saving capital gains on your business sale? Check out our blogs on Asset vs. Stock Deals, Installment Sales, Structured Installment Sales, Qualified Opportunity Zone Funds, Tax Loss Harvesting, Employee Stock Ownership Plans (ESOPs), and Qualified Small Business Stock Exclusions (QSBS).

[1] To reach the value of the charitable deduction, I applied the top federal rate and Georgia’s taxes to reach the estimated tax savings. True value of the deduction may be limited by AGI limitations and itemized deduction rules.

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